In the wake of the 2008 financial crisis, American corporations began holding onto as much cash as they could get their hands on. Fearing another liquidity crisis, they hoarded the greenback, with S&P 500 non-financial companies’ collective amount of cash and cash equivalents rising from less than $800 billion in the third quarter of 2008 to over $1 trillion by mid-2010.
The trend has not stopped, even with ultra-low interest rates keeping returns on cash near zero. At the end of 2014, the S&P cash and cash equivalents pile had grown to $1.43 trillion, according to FactSet. Part of that has to do with lingering fears that another financial crisis will hit, but a big part of it has to do with companies not wanting to pay US repatriation taxes on their growing foreign profits, since US taxes are higher than those of most other countries.
As an investor, this can be incredibly frustrating. General Electric Company, for example, has well over $100 billion of cash parked overseas, according to a recent analysis by Credit Suisse. Given that GE has earned a return on retained earnings — that is, the earnings it has held onto and not paid out as dividends — of -1.9% over the past decade, investors can certainly make the case that they would be better off if GE repatriated a chunk of that money and returned it to shareholders via dividends or buybacks.
But it’s important to remember that some companies do a great job redeploying their cash to grow their businesses, which in the long run can turn out far better for shareholders than dividends or buybacks. Warren Buffett famously does not pay dividends at Berkshire Hathaway, because he thinks he can use the company’s cash in a way that better benefits shareholders than simply paying it out in dividends. His long-term track record shows that he’s right.
Not surprisingly, return on retained earnings is one criterion Buffett looks at when assessing a stock, according to Mary Buffett’s books Buffettology and The New Buffettology. “Warren believes that if a company can employ its retained earnings at above-average rates of return, then it is better to keep those earnings in the business,” writes Ms. Buffett, who worked closely with Mr. Buffett and is his former daughter-in-law, in Buffettology. She adds, “Whether or not the management of the company can utilize its retained earnings is probably the single most important question you must ask yourself as a long-term investor in businesses. Commitment of capital to a company that has neither the opportunity nor the managerial talent to grow its retained earnings will cause your investment boat to become dead in the water.”
So, what kinds of companies have track records of growing retained earnings at high rates? Well, my Buffett-based “Guru Strategy”, a computer model inspired by Buffett’s approach (as laid out by Mary Buffett) looks for stocks with a return on retained earnings of at least 12% over the past decade. To determine this figure, we simply take the amount the company’s earnings per share have increased over the past 10 years, and divide it by the amount of retained earnings it has had over that period. Here is a quartet of stocks that fit the bill, and which also have high overall scores on my Buffett-inspired model. Think twice before getting upset with these companies if and when they have high cash balances — if history is any indication, they may be about to do something very productive for both their business and shareholders with those funds.
Monster Beverage Corp (NASDAQ:MNST): This California-based firm ($21 billion market cap) makes energy drinks and alternative beverages under such names as Monster Energy, Java Monster, X-Presso Monster, M-3, Worx Energy and Hansen’s natural sodas and juices. While Buffett himself is a big fan of Coca-Cola and its stock, my Buffett-based model prefers Monster, thanks in part to its having a 19.6% return on retained earnings over the past decade. The Buffett-inspired model also looks for consistent earnings and reasonable debt, and Monster delivers on both fronts. The firm has increased earnings per share in all but one year of the past decade, and it has no long-term debt.
The TJX Companies Inc (NYSE:TJX): This parent of discounters Marshalls, T.J. Maxx, and Home Goods ($44 billion market cap) has averaged a 17.7% return on retained earnings over the past decade. In addition, it has increased EPS in each year of that stretch, and it has enough annual earnings ($2.2 billion) that it could, if need be, pay off all of its debt ($1.6 billion) in well under two years, the standard my Buffett-inspired strategy prefers.
Wipro Limited (ADR) (NYSE:WIT): This India-based global I/T firm ($21 billion market cap) took in more than $7 billion in sales in the last year, and has generated a return on retained earnings of 16.8% over the past decade. It has also upped EPS in each year of the past decade, and has less than $200 million in debt and more than $1.3 billion in annual earnings. In addition, Wipro’s 10-year average return on equity is an impressive 24.2%, and anything over 15% is a sign of the “durable competitive advantage” Buffett is known to seek.
FMC Technologies, Inc. (NYSE:FTI): This Houston-based firm ($10 billion market cap) is a global leader in subsea systems and a leading provider of technologies and services to the oil and gas industry. It helps its customers improve shale and subsea infrastructures and operations to reduce cost, maintain uptime, and maximize oil and gas recovery. The company has approximately 20,000 employees and operates 24 production facilities in 14 countries.
Oil and gas services companies have been hit quite hard by the downturn in oil prices we’ve seen over the past year, but FMC seems to be holding up relatively well — it actually increased earnings per share (compared to the year-ago period) in the first quarter. It has also generated a 17.8% return on retained earnings over the past decade, part of why get strong interest from my Buffett model. A couple other reasons: FMC has upped EPS in each year of the past decade, and it has enough annual earnings ($707 million) that it could pay off its debt ($1.3 billion) in less than two years, if need be.